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In compound interest, the interest earned by the principal at the end of each interest period (compounding period) is added to
the principal. The sum (principal + interest) will earn another interest in the next compounding period.

Consider $1000 invested in an account of 10% per year for 3 years. The figures below shows the contrast between simple interest
and compound interest.

At 10% simple interest, the $1000 investment amounted to $1300 after 3 years. Only the principal earns interest which is $100
per year.

At 10% compounded yearly, the $1000 initial investment amounted to $1331 after 3 years. The interest also earns an interest.

Elements of Compound Interest

P = principal, present amount
F = future amount, compound amount
i = interest rate per compounding period
r = nominal annual interest rate
n = total number of compounding in t years
t = number of years
m = number of compounding per year
r
m
i=

and

n = mt

Future amount,

F=

The factor

(1 + i)n

P(1 + i)n

or

r
m
F = P 1+

( )

mt

is called single-payment compound-amount factor and is denoted by

(F /P, i, n).

Present amount,
F
n
P = (1 + i)

1
The factor

(1 + i)n

is called single-payment present-worth factor and is denoted by

(P /F, i, n).

Number of compounding periods,

ln(F /P)
ln(1
+ i)
n=

Interest rate per compounding period,

i=

Values of i and n
In most problems, the number of years
shows the value of i and n.
Example
Number of years, t = 5 years
Nominal rate, r = 18%
Compounded annually (m = 1)
n = 1(5) = 5

F
P 1

and the number of compounding periods per year

are given. The example below

i = 0.18 /1 = 0.18
Compounded semi-annually (m = 2)
n = 2(5) = 10
i = 0.18 /2 = 0.09
Compounded quarterly (m = 4)
n = 4(5) = 20
i = 0.18 /4 = 0.045
Compounded semi-quarterly (m = 8)
n = 8(5) = 40
i = 0.18 /4 = 0.0225
Compounded monthly (m = 12)
n = 12(5) = 60
i = 0.18 /12 = 0.015
Compounded bi-monthly (m = 6)
n = 6(5) = 30
i = 0.18 /6 = 0.03
Compounded daily (m = 360)
n = 360(5) = 1800
i = 0.18 /360 = 0.0005

Continuous Compounding (m )
In continuous compounding, the number of interest periods per year approaches infinity. From the equation
r

( )

F = 1+ m

mt

when

m , mt = ,
r
lim
mt
F = P m 1 + m

and

r
m 0.

Hence,

( )

Let

r
x = m.

When

m ,

x 0,

and

r
m = x.

r
lim
x
F = P x 0 (1 + x) t
1
lim
x
F = P x 0 (1 + x) rt

From Calculus,

lim

x (1 + x) 1 /x

= e,

thus,
F = Pert

Tags: simple interest compound interest present amount future amount nominal rate interest rate continuous compounding
Fifty Thousand Pesos Split into Two Simple
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Submitted by marlonken on May 21, 2016 - 3:10am

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